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Commentary

Platinum may be reasonably priced

19 Oct 2011 by Jim Fickett.

Although the precious metals market has cooled lately, gold remains 143% above its 40-year, inflation-adjusted price; silver 112% above, palladium 85% and platinum 65%. Note that, of the four, platinum is closest to its historical average price.

Demand for platinum has increased significantly in recent years, due to its use in catalytic converters, especially for diesel, so perhaps some rise in price over time is appropriate. Johnson Matthey, the precious metals refiner and dealer, publishes a comprehensive report on the platinum group metals twice a year. The most recent one, which came out last May, reports that supply and demand in the platinum market were in balance in 2010:

The recovery of the global economy in 2010 helped drive gross demand for platinum up by 16% to 7.88 million ounces, its highest level since 2008. Supplies remained largely flat at 6.06 million ounces while open loop recycling of platinum increased to 1.84 million ounces. The platinum market tightened in 2010 and ended the year very close to balance, with a 20,000 oz surplus.

Unlike for silver, the platinum market is driven by industrial demand, with investment demand running at less than 10% of overall demand. This suggests that the current price is driven mainly by genuine demand, and not speculation.

Further, the Financial Times reported this week that the current price is close to the marginal cost of production:

After a price drop of about 19 per cent and 23 per cent respectively for platinum and palladium since the start of September, the PGMs are trading close to or below the price at which some miners break even. …

A recent report by Barclays Capital ranking commodities by the degree of vulnerability to a 2008-type financial crisis puts platinum among the “beautiful” along with cotton and cocoa. At current levels of about $1,530 an ounce, the metal is far below BarCap’s estimate of its “cost floor” of $1,700-$1,800, which means high-cost producers are losing money. If they start cutting production, platinum prices would be unlikely to fall further, even if some of the market’s worst fears about the eurozone crisis are realised.

Although the current price is reasonable, it is still the case that there is little margin of safety. The FT goes on to say,

So will production cuts in platinum happen any time soon? One reason to be sceptical is that, while the US dollar price of platinum has fallen very sharply, the price in South African rand terms remains above R12,000 an ounce, which mining executives and analysts see as the price at which the highest cost producers break even.

Since three-quarters of the precious metal’s supply comes from South Africa, the rand price is the most relevant to costs. …

South Africa’s platinum mines, deep below the surface, are difficult and expensive to shut down, while the price of labour suspensions and political pressure are also huge disincentives of production cuts.

It is therefore misguided to assume that they will cut their production in a downturn in prices, says Dominic O’Kane, analyst at Liberum. In his view, platinum miners have the worst “production discipline” of any commodity producers. Investors attempting to pick the bottom of the slump in industrial commodity prices, then, should be wary of assuming that the cost of production will provide a steady floor for the platinum price.

I do have a small position in platinum, bought long ago, but I would not particularly recommend buying at the current price. When China slows there will probably be a better opportunity.